The Effectiveness of Capital Regulation on Bank Behavior in China

This paper examines the impact that ownership and governance structures have on how Chinese banks react to regulatory pressure. We find that the current regulatory regime induces banks to increase their capital, but its effectiveness in doing so varies based on whether the bank is listed or not, and also who is the majority shareholder. We also find that the degree of central government ownership and the political ties the chief executive officer of the bank has play an important role in the risk-taking behavior of banks. Overall, our results have a number of policy implications supporting the need to further reduce state ownership of banks in China to mitigate the prevailing moral hazard and dual-agency problems that arise from the government being both the regulator and the majority shareholder.